Years ago, I found myself sitting in law school in Moot Court wearing an oversized itchy blue suit. It was a horrible experience. In a desperate attempt to avoid anything like that in the future I enrolled in a tax course. I loved it. I signed up for another. Before I knew it, in addition to my JD, I had a LL.M Taxation. I needed only to don my cape…. taxgirl® was born. Today, I live and work in Philadelphia, PA, one of the best cities in the world (I can't even complain about the sports teams these days). I landed in the City of Brotherly Love by way of Temple University School of Law. While at law school, I interned at the estates attorney division of the IRS. At IRS, I participated in the review and audit of federal estate tax returns. I even took the lead on a successful audit. At audit, opposing counsel read my report, looked at his file and said, “Gentlemen, she’s exactly right.” I nearly fainted. It was a short jump from there to practicing, teaching, writing and breathing tax.

Taxes From A To Z (2013): F Is For Fellowships and Scholarships

JOPLIN, MO - MAY 21: A student decorated her mortar board during the Joplin High School Commencement Exercises for the Class of 2012 at the Missouri Southern State University Leggett & Platt Athletic Center on May 21, 2012 in Joplin, Missouri. (Image credit: Getty Images via @daylife)

F is for Fellowships and Scholarships.

More and more students are relying on fellowships and scholarships to help defray the cost of college education these days. For tax purposes, a fellowship is an amount paid to or on behalf of a student for research purposes. A scholarship is an amount paid to or on behalf of a student for the purpose of study.

Normally, all or part of what you receive as part of a fellowship or scholarship is tax free so long as you are a candidate for a degree at an educational institution and the amounts you receive are considered qualified educational expenses. You can’t get around the degree requirement: if you’re not a degree candidate, the full amount is subject to tax even if you use it for educational expenses. Additionally, the fellowship or scholarship cannot exceed your expenses and can’t be designated or earmarked for other other purpose.

For tax purposes, an education institution is generally one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities. Qualified educational expenses include tuition and fees required to enroll at or attend an eligible educational institution, and required course-related expenses, such as fees, books, supplies, and equipment.

Payments for other expenses, including room and board and living expenses stipends, are not considered qualified education expenses. Other expenses that don’t qualify include travel, research, clerical help or equipment and other expenses that are not required for enrollment in or attendance at an eligible educational institution. Those must be included in gross income.

You also have to include payments received in exchange for services. Those services include teaching, research, or other services even if they required as a condition for receiving the fellowship or scholarship and even if there are restrictions or penalties imposed if you do not comply with the requirement to perform services. There are some exceptions to this rule: you don’t have to include in income payments for services under the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program. Additionally, payments you receive for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free.

Federal and state educational grants are treated like scholarships for tax purposes (since most federal and state educational grants are used for tuition, that usually means they’re not taxable). And don’t get carried away with cachet: prestigious awards like the Fulbright grant are treated the same as all others.

Keep in mind that universities are not required to issue a form W-2 or 1099 to you – though they certainly may do so – for fellowships and scholarships unless there is a services for compensations component (you will receive a form W-2 for income related to performing services). You have to report any taxable fellowships or scholarships even if you don’t receive any tax forms. If you do receive a form W-2 or 1099 which includes excludable income, report the taxable amount and include an explanation about the excluded portion. However, if the only income you receive during the year is a tax-free fellowship or scholarship, you do not have to file a return.

And remember: no double dipping. You can’t exclude fellowships and scholarships from income and then deduct the same as educational expenses.

(Psst: The information in this post refers to U.S. citizen students. Different rules may apply to foreign students. Check with your college or tax professional for more information.)

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